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Oil, gas severance tax hike in Ohio ill-advised
By Thomas E. STEWART
In less than two years, Ohio’s emerging shale industry has brought a bounty of high-paying jobs and economic opportunities to the state, particularly to communities in eastern Ohio that have struggled economically for decades.
According to a recent study conducted by the respected analytic firm IHS, Ohio currently has more than 38,000 jobs related to energy development within the state’s Utica shale formation — a number that is expected to grow to more than 140,000 by 2020.
Now, with job numbers like those, one would think that the administration would put out the welcome mat for the energy companies that have invested billions to explore the Utica shale play. Instead the administration labeled those out-of-state businesses as “foreigners” and introduced a proposal to increase the severance tax on oil and gas production to keep said “foreigners” from taking profits made from Ohio’s natural resources out of the state.
This is a ridiculous notion. First of all, many out-of-state companies have partnered with independent, Ohio-based oil and gas producers on exploration and drilling activity who are sharing in the risks and profits.
State consumption
Second, a lot of the oil and gas produced in Ohio will stay in the state. Manufacturers throughout Ohio depend on oil and gas to fuel their operations and having a steady supply will help them grow, which means more jobs and economic opportunities for Ohioans. With a diverse manufacturing base, Ohio will not fall prey to what some pro-tax advocates have called the “natural-resources curse,” where resource-based economies are doomed to a cycle of boom and bust.
Third, despite widely held public opinion, oil and gas production has a fairly low profit margin of approximately 7 percent. But even when a profit is made, the majority of oil and gas producers reinvest it right back into the next well. It should also be noted that Ohio land and royalty owners, many of whom are farmers, would also be burdened with the increased severance tax.
Proponents of the tax increase say that it’s modest. However, when you do the math, the proposal amounts to a 1,500-percent tax increase on oil production. I believe you would be hard pressed to find a taxpayer who believes that’s a modest increase. Furthermore, the severance tax would be collected whether or not a well was profitable, which means it equates to a 4-percent, off-the-top, gross-receipts tax on oil.
In addition to the severance tax, oil and gas producers also pay income, sales, ad valorem (property) and the commercial activity tax (CAT). For perspective, most Ohio businesses pay the .26 percent CAT. The administration’s severance-tax increase is 15 times the current CAT. How would other Ohio businesses react if the CAT were suddenly increased to 4 percent?
Expensive endeavor
Oil and gas exploration is an expensive, risky endeavor. The cost of constructing a horizontal Utica well can cost between $7 and $12 million and the companies drilling in eastern Ohio have no guarantee of a return on their investment. The more a producer can reduce costs, the more the producer can offset severe decline rates. Producers drill new wells using net revenue cash flow from existing production. The more wells a producer drills by investing net revenue, the more Ohio workers, businesses and communities will benefit.
While investment has continued since the severance-tax increase was proposed in 2012, the fact is that we’re still in the research-and-development phase of Utica shale development. Though the Utica holds great potential, we may not know its real value or viability for months or even years to come.
If the severance-tax increase is enacted and the Utica fails to live up to expectations, the math may not make sense for some companies and they might choose to invest in one of the other promising shale plays in the U.S. or abroad.
Thomas E. Stewart is executive vice president of the Ohio Oil and Gas Association in Granville.